P2P Lending – A twist or a stick?

Imagine applying for a loan by entering a few pieces of information into an online application portal, and within hours having your loan approved for funding. A number of online marketplace lenders globally have made this a reality, offering online platforms that match borrowers directly with investors. This so-called peer-to-peer (P2P) or market place lending model is growing in popularity with borrowers because of its perceived low interest rates, simplified application process, and quick lending decisions. This model is rapidly expanding to new product categories including mortgages and other secured loans.

Although still in its infancy as a market, P2P lending firms in the US and UK in 2010 generated cumulative lending of USD 1.5m and this increased to USD 7bn in 2015 so unprecedented rise in the demand. In the US alone, in 2015, P2P platforms issued approximately $6bn in loans and based on our global analysis, this is expected to grow to $150bn by 2025 (25 times or 2400% over 10 years).

The estimated P2P lending to be generated in India over the next 5 years is pegged at circa USD 4bn (160 times the current lending size). Still this is way too low compared to China where there are circa more than 2000 P2P lending firms with a lending book size north of circa USD15bn indicating the potential to grow exponentially in India.

India's P2P lenders currently number around 30 online platforms with a current loan book of circa USD 25m. Some of these firms are expected to become the biggest disrupter in democratising the availability of credit to SME borrowers and others in India. The RBI’s (Reserve Bank of India) draft consultation on P2P lending on April 2016 clarifies the scope of P2P lending activities and the prudential and governance requirements for such firms.

1. Weak underwriting process resulting in bankruptcy of the P2P firm due to poorly executed business model resulting in granting loans to scrupulous borrowers with poor credit history

2. Regulating the loan disbursement cash flow model to transfer cash from lender’s bank account to borrower’s bank account directly (as currently contemplated by the RBI in its draft consultation paper) could result in huge operational complexities for the platform firm to keep track of loans disbursed and amount repaid.

3. Absence of creating a segregated trust account by the P2P firm to track cash flows between lenders and borrowers could potentially result in mis-appropriation of funds by the platform firm

4. Data privacy laws could be breached if the platform firms disclose the names of the borrowers and lenders in their website.

5. If KYC and AML checks are not carried out robustly, the platform firms could be used for money laundering and routing illegal sources of funding.

6. Absence of an adequate recovery and resolution process (RRP) of the failed platform firms could put the lenders money at stake and may cause operational and legal challenges for the borrowers as well.

7. Absence of a robust front to back IT system could result in various errors and breaches of the RBI regulations including in-accurate record keeping by the firms.

8. Lack of strong cyber security controls could expose the platform firm and the money held by the firm on behalf of its lenders to hackers who can penetrate and access all the required details to siphon away the money and use their details for competitive advantages.

Our perspectives

1. Platform based lending will invariably gain huge momentum over the next 3-5 years due to competitive interest rates and ease of making finance available.

2. Secured lending may have a better preference from a risk averse investor stand point due to the fact that this business has progressed very well since the past 5 years and there are established RBI regulations governing this type of lending.

3. RBI may potentially exercise greater regulatory scrutiny on unsecured P2P lending due to the systemic nature of risks involved to the end customers where they may lose all their money if the loan under-writing process is not robustly managed.

4. Over a period of time, if unsecured P2P lending is well established like in the developed markets (e.g. Funding Circle in the UK), banks and institutional investors will potentially look to buy blocks of P2P loans to add to their portfolios.

5. With increasing focus on automation and innovation in offering the loan products to lenders and borrowers, P2P firms may need to seek periodic assurance over the design and operating effectiveness of their processes and internal controls, both from a business and IT perspective to ensure the data integrity of the platform is not compromised at any given point in time both externally and internally within the firm.

Consumers are hungry for a simplified, streamlined lending process, and P2P firms are capitalizing on this need – creating a loyal and growing following. It’s this recent growth, and future growth potential, that has banks taking notice.

Many financial institutions are beginning to examine the changes that are on the horizon. As a new competitor, P2P companies could shake up the market; but along with any disruption is the potential for opportunity. The question financial institutions should start considering is whether their organizations will collaborate or compete with P2P lending platforms.

DISCLAIMER: The views expressed are solely of the author and ETtech.com does not necessarily subscribe to it. ETtech.com shall not be responsible for any damage caused to any person/organisation directly or indirectly.